GLOBAL INVESTOR 3.06 Switching — 64 Economic backdrop in emerging markets to remain favorable While consumers in the emerging markets are increasingly dem<strong>and</strong>ing br<strong>and</strong>ed products, af<strong>for</strong>dability pressure, competition from cheap local br<strong>and</strong>s, commodity pressures <strong>and</strong> reputational risks remain the greatest operating challenges.
GLOBAL INVESTOR 3.06 Switching — 65 mont) are strong product categories as their monetary value is easily identifiable. It is also not surprising that leather goods (Louis Vuitton, by LVMH) <strong>and</strong> accessories with strong recognizable br<strong>and</strong>s are growing rapidly. Depending on the rate of urbanization <strong>and</strong> wealth creation, we expect that the mix of emerging market consumers, especially in China, will gradually rebalance in two ways. The importance of male shoppers should diminish in favor of women <strong>and</strong> younger customers, as economic growth will translate into more social independence <strong>and</strong> disposable income. The development of local infrastructure (malls, transport) should benefit domestic sales, in particular accessories <strong>and</strong> ready-to-wear. Premiumization is paramount to spirits producers In emerging markets, there is continuing trading up from local beer to international beer <strong>and</strong> champagne <strong>and</strong> from local spirits to international br<strong>and</strong>ed spirits, especially Scotch Whiskey <strong>and</strong> Cognac. We expect China <strong>and</strong> Russia to remain the key growth regions, driven by premiumization <strong>and</strong> rising per capita spending. SAB Miller, InBev, Diageo <strong>and</strong> Pernod Ricard all earn a significant part of their sales in emerging markets, ranging from 80% down to 25%, respectively. We believe that this share is likely to further increase, driven by a still high growth differential between emerging markets, particularly Asia (spirits: +3.3% CAGR 2003 – 2008, Euromonitor), Latin America (beer: +2.7%) <strong>and</strong> Eastern Europe (beer: 4.8%), <strong>and</strong> developed countries (e.g. Western Europe, +0.3% <strong>for</strong> spirits <strong>and</strong> +0.1% <strong>for</strong> beer). We note that volatility in sales volumes in the emerging markets is likely to be higher than in the developed countries. The main growth driver at Coca-Cola <strong>and</strong> PepsiCo Emerging markets have been very important <strong>for</strong> Coca-Cola <strong>and</strong> PepsiCo over the past five years. We estimate emerging markets have contributed 75% of Coca-Cola’s incremental volumes <strong>and</strong> roughly 60% of PepsiCo’s beverage growth since 2000. Emerging markets also drive a large portion of the two companies’ long-term profit growth algorithms. We <strong>for</strong>ecast 60% of Coca-Cola’s profit growth <strong>and</strong> 50% of PepsiCo’s (including snacks) is targeted to come from those markets between 2005 <strong>and</strong> 2010. We estimate a 1% change in emerging market GDP causes a 0.9% change in these two companies’ emerging markets sales. We believe the economic backdrop in emerging markets remains favorable but business risks linger. The greatest operating challenges include af<strong>for</strong>dability pressures, competition from cheap local br<strong>and</strong>s, commodity cost pressures, <strong>and</strong> reputational risks. Figure 1 Source: Credit Suisse estimates (July 2006) Real GDP growth by region According to Credit Suisse <strong>for</strong>ecasts, emerging market regions will continue to outper<strong>for</strong>m the developed countries in terms of GDP growth. % 10 Rising middle class buying more consumer electronics Another consumption trend in emerging markets in the offing is the migration from cathode ray tube TVs to flat panel TVs, <strong>and</strong> this is already evident in China. Rising incomes among the middle class in emerging markets, rapidly falling prices <strong>and</strong> improved functionality are increasing the penetration of consumer electronics in emerging markets. With regards to br<strong>and</strong> perception, consumers in emerging markets value <strong>for</strong>eign br<strong>and</strong>s more when buying consumer electronics. Recently, in June 2006, Brazil’s government said that it would adopt Japanese technology as the basis <strong>for</strong> its digital TV st<strong>and</strong>ard, which suggests that Japanese consumer electronics would be the major beneficiaries. Sony has established a strong br<strong>and</strong> name in emerging markets thanks to the success of its legacy businesses of walkmans, videocassette recorders <strong>and</strong> TVs. Matsu- 5 0 Emerging markets Latin America 2005E 2006E 2007E Emerging Europe Emerging Asia Developed markets (OECD)
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